Psychology & Risk: POST 6
Alright, so you’ve got the risk management basics down pat: using stop losses like a pro, figuring out your position size , and understanding risk vs. reward. That’s your essential toolkit – your helmet and pads. Now, let’s talk about adding some more sophisticated armor to your defense. These aren’t things you need on day one, but knowing about them helps you become a smarter, more adaptable trader down the road.
1. Scaling In & Out: Entering and Exiting in Pieces
Instead of jumping in or out with your whole position at once, you can break it into smaller chunks.
- Scaling In: Maybe you put on only half your intended size when you get the first entry signal. If the trade starts moving your way and gives you more confirmation (like breaking a key level), then you add the second half.
- Why bother? Can sometimes get you a better average price; lets you “test the waters” before committing fully.
- Heads up: It’s trickier to manage, you might miss the big move if it takes off instantly, and you MUST calculate your total risk based on the full intended size and your stop. Never, ever, ever add to a trade that’s going against you! That’s averaging down, and it’s account suicide.
- Scaling Out: As a winning trade moves towards your target, you might sell off parts of it. Like, sell a third at 1R (when you’ve made 1x your initial risk), sell another third at 2R, and let the last piece run with a trailing stop to potentially catch a bigger move.
- Why bother? Locks in some profit, reduces your risk on the rest of the position, and can be psychologically easier than holding everything for one big target (less fear of giving it all back!).
- Heads up: Might make less overall if the trade zooms straight to your final target; you need clear rules for where you take profits.
2. Watching Out for Correlation: Don’t Put All Your Eggs in One Sector Basket
Trading multiple stocks at once? Cool, but watch out for correlation. If you go long on three different solar energy stocks because the whole sector looks hot, you haven’t really spread your risk much. If the whole solar sector tanks, all three of your trades likely go down together. You’ve basically made one big bet, not three separate ones.
- What to do:
- Be aware of which stocks or assets tend to move together (e.g., stocks in the same industry, oil prices and energy stocks, different currencies tied to the US dollar).
- If you take multiple trades that are highly correlated, consider using smaller position sizes on each one so your total exposure to that one theme or sector stays within your comfort zone. Risking 1% on three stocks that move in lockstep is really like risking 3% on one idea.
3. Checking Your “Portfolio Heat”: How Much Risk Are You REALLY Taking?
This ties into correlation. It’s about knowing the total percentage of your capital at risk across all your open trades at any given moment.
- Example: You have 4 open trades, each risking 1% of your account. Your “portfolio heat” is 4%.
- If those 4 trades are all in, say, semiconductor stocks, your effective risk feels even higher because one bad piece of news for the industry could hit all of them.
- Why track this? It stops you from accidentally piling on way too much overall risk, even if each individual trade seems small. Decide on a maximum portfolio heat you’re comfortable with (maybe 5%, 8%, 10% – depends on your tolerance) and don’t exceed it.
4. Flexing Your Size with Volatility: Trading Smaller When It’s Choppy
Your standard “% risk per trade” rule is awesome, but you can fine-tune it. The market isn’t always equally wild or calm, right? Some days are super choppy; some are quiet.
- The Idea: Use a tool like ATR (Average True Range) to get a sense of how much a stock has been bouncing around lately.
- How to Use It:
- When volatility (ATR) is high, price swings are bigger. You might need a wider stop loss (in dollar terms) just to avoid getting stopped out by random noise. To keep your risk at, say, 1% of your account with that wider stop, you’ll need to trade a smaller number of shares.
- When volatility (ATR) is low, price swings are smaller. You might be able to use a tighter stop loss, which means you could potentially trade a larger number of shares for that same 1% risk.
- The Payoff: Helps keep your actual risk exposure more consistent day-to-day, regardless of market craziness. It takes an extra calculation step, but it can really smooth out your results.
5. The Circuit Breaker: Your Max Daily/Weekly Loss Limit
This one isn’t about a single trade; it’s about protecting your entire account and your sanity.
- The Rule: Decide, in advance, the absolute maximum amount (or percentage) of your capital you are willing to lose in one single day, or one single week. Write it down.
- The Action: If you hit that loss limit? YOU ARE DONE TRADING FOR THE DAY/WEEK. Full stop. No negotiations, no “just one more trade.” Close the platform. Walk away. Go do something else.
- Why it’s GOLDEN: This is your emergency brake. It prevents those catastrophic days where one loss leads to frustration, which leads to revenge trading, which leads to bigger losses, and spirals into blowing up your account. It forces discipline when you need it most and ensures you live to trade another day. Honestly, this might be the single most powerful risk tool there is.
These aren’t beginner techniques, so don’t feel pressured to use them all right away. Master the basics first. But keep these advanced ideas in your back pocket. As you get more experienced, layering these in can seriously level up your risk management game. And remember, job #1 is always protecting your capital!
- What’s Next? We’ve focused a lot on the ‘Risk’ part of Risk/Reward. Let’s swing back to the ‘Reward’ side and the psychology of actually letting your winners, well, win!
